G20 currency truce shortlived as Japan mulls foreign bond buys

Japan’s premier has left the door open for outright purchases of foreign bonds
to weaken the yen, a move that would risk a serious clash with the US and
Europe and a fresh escalation in global currency tensions.

Japan did buy foreign bonds after the Fukushima disaster in early 2011 to stop the yen surging to record levels on safe-haven flowsPhoto: Bloomberg News

Shinzo Abe told Japanese politicians that intervention on the markets is among the options being discussed. “There are views calling for foreign bond purchases,” he said, pointedly refusing to rule out such action.

The comments come despite a G20 statement over the weekend committing all major powers to “refrain from competitive devaluation”.

Buying foreign bonds is not the same as quantitative easing (QE) by the US and Britain, and crosses a sensitive political line. “It would be a direct violation of the G20 statement,” said Hans Redeker from Morgan Stanley. “We think he is saying this to convince markets that Japan has unlimited firepower to hold down the yen if absolutely necessary. He is trying to break the deflation psychology once and for all.”

Geoffrey Kendrick from Nomura said the unwritten rule is that devaluation as a QE side-effect is allowable because the policy is targeted at the internal economy, chiefly to head off deflation and drive down unemployment.

“People are going to get upset if the Japanese go for direct foreign exchange intervention. The US is worried that if they let Japan do it, they can’t easily stop China doing it,” he said.

Mr Abe renewed his threat to overhaul the Bank of Japan’s (BoJ) mandate if it drags its feet on his reflation strategy. “We’d have to revise the BoJ law if the central bank can’t produce results,” he said. He is expected to announce a new governor next week who is willing to tear up the rule book and try the sort of radical policies that pulled Japan out of its slump in the early 1930s.

Outgoing governor Masaaki Shirakawa is a monetary hawk who has fought to uphold orthodoxy. His only concession has been “QE-lite”, buying short-term debt from Japanese banks. Critics say this does little to boost the broad money supply and amounts to policy paralysis.

The world turned a blind eye last year as Switzerland carried out massive purchases of European bonds to cap the franc at €1.20, but Japan is 14 times as large. Comparable action by Tokyo would upset the global trading system.

Japan did buy foreign bonds after the Fukushima disaster in early 2011 to stop the yen surging to record levels on safe-haven flows. The move was tolerated as a “one-off” emergency response.

The picture is now different. The yen has already weakened by 30pc against the euro and 20pc against the dollar since October, when it became clear that Mr Abe would win a landslide election victory with a mandate for reflation. The yen touched ¥94 on Monday – its weakest in three years – and the Nikkei index of stocks rose 2pc as funds dismissed the G20 text as a weak compromise. Tokyo’s bourse has risen 30pc since October.

“The key message we took was that it was a green light for Japan to continue with its new monetary and fiscal policies, but Japan should refrain from being too blatant,” said Stephen Jen from SLJ Macro Partners. He expects the yen to weaken to 110 as Japanese life insurers, funds and banks adapt to the new world of “Abenomics”.

Morgan Stanley said these funds have $6.6 trillion (£4.3 trillion) of foreign holdings. Many of their assets are “hedged”, which boosts the yen. “We think the funds have changed their view entirely over the last three months [and] will now start to unwind these hedges,” said Mr Redeker. This could lead to a second leg of yen weakness.

Nobel economist Paul Krugman said currency wars are a “net plus” for a world economy caught in a liquidity trap. They act as a form of global monetary stimulus and resemble moves to break free of the Gold Standard in the slump. “What Japan, the US and the UK are doing is trying to pursue expansionary monetary policy, with currency depreciation as a by-product. Expansionary policy is what the world needs,” he said.

“True, Europe may feel that it’s suffering a loss of competitiveness. But there’s an answer for that: emulate the other advanced countries, and have the European Central Bank join in the expansion. That’s good for everyone.”